Thursday, 27 April 2017

How To Convert Your Financial Goals To Financial Plan

In this article, we are going to cover the fourth step of financial planning. That is converting your financial goal to a financial plan. The hierarchy of investment needs before we actually start investing for a short term and long term goals you should take care of two things:
  1. Contingency funds.
  2. Life and Medical insurance.


Contingency Funds

Let us see how to calculate the current contingency funds. It is something that is described by the expense ratio. It is nothing but the amount of your current savings account plus your fixed deposit plus cash that you have divided by your monthly expenses. Monthly expenses would include all your out goals like your EMIs, household expenses, your insurance premiums, etc. Expense ratio should be 6 for salaried people and 12 for professionals and business peoples. Why 12 for business people and professional people is because their income is variable, whereas the monthly expenses are constant. Contingency funds are helpful in situations like job loss, sudden medical expenses, etc. After your contingency funds are ready, your life insurance with critical insurance cover accidental disability cover and your medical insurances should be in place and then you should move on to your short term goals, medium and long term goals.

The hierarchy does not mean that your short term, medium and long term goals are less important. What it means is first you should be ready for sudden events like job loss, health issues life loss and then you should plan for your short-term goals because they are the most immediate ones and then you should plan for your medium and long term goals. In the first step of financial planning that is understanding your current financial status, we had seen the cash flow statement of Alex and John. In step two we have seen what are the common goals it people generally have. Based on the surplus that Alex and John have. Let's see whether they are able to invest towards the common goals. But before we do that, let's check what is the expense ratio.

The amount of the savings account + current account + FD's + cash, divided by the EMI + household expenses + the insurance premiums comes out to be 7.8. Since Alex and John are salaried people, this looks to be a good expense ratio. Alex and John Currently paid 2.4 lakh rupees as life insurance premiums which seemed to be very heavy so this should be replaced by our term plan. You can read our articles on insurance not an investment and how to calculate your right life insurance cover to understand this better. After buying a term plan these 2.4 lakh rupees would be available for investment and so now their monthly surplus would be forty nine thousand six hundred rupees. Let's check with this amount in hand how they can invest towards their four goals.

The only short-term goal that they have is buying a bigger house after 3.3 years because by this time they will finish off their existing home loan. The house they want to buy currently costs around 1 crore rupees. If inflation is assumed at 7 percent, then the future cost would work out to be 1.24 crore rupees. They plan to sell off the current house they live in when they buy this bigger house. The current price of that house is 75 lakh rupees and if inflation is again assumed at seven percent, the future cost of this house would be 93.95 lakh rupees and so when they sell off that house, they would have a shortfall of 31.31 lakh rupees when they buy this bigger house.


Taking a home loan is a better idea than parting away with your liquidity or investments. Because this is the most cheapest form of loan that is available. It also comes with tax benefits. Read our article SIP vs EMI to see how beneficial it is to have a SIP rather than prepaying your home loan. So after 3.3 years if Alex and John take a home loan for 20 years at the rate of interest of 10 percent the EMI works out to be thirty thousand two hundred and twenty two rupees. Since Alex and John are taking a home loan for this particular goal, there is no investment required.

We have put he rest of the goals together on this page to see whether forty nine thousand six hundred rupees of investment are enough to satisfy all of them. We have suggested two options of investment towards each goal, option 1 is an SIP into debt oriented hybrid funds which may give returns about ten percent. Option two is, SIP into diversified equity mutual funds which may returns of about twelve percent. The second goal that Alex and John have is their child's higher education in the US. The current cost is 25 lakh rupees their child is six years old, so the time available is 16 years, the future cost works out to be 73.8 lakh rupees if inflation is assumed at seven percent.

Option one of SIP into debt oriented hybrid funds which may give returns of about ten percent, works out to be 15,888 rupees. The option two of SIP into diversified equity mutual funds which may give returns of about twelve percent works out to be twelve thousand eight hundred and twenty two rupees. The next goal is their child's marriage as of today they would want to spend 15 lakh rupees. They have eighteen years and hand and the future cost if inflation assumed at seven percent works out to be 50.69 lakh rupees. Option 1 of SIP into debt oriented hybrid funds which may give returns about 10 percent works out to be 8,442 rupees whereas option 2 with SIP into diversified equity mutual funds which may give returns of about twelve percent works out to be 6,690 rupees. Their last goal is retirement, which is 23 years away and the cop is required for retirement is 4.16 crore.

To accumulate this corpus they would need a SIP of 46,893 rupees into debt oriented hybrid funds which may give returns of about 10 percent or a SIP of 28,548 rupees into diversified equity mutual funds which may give returns of about 12 percent. The value is required to calculate the retirement corpus, a household expenses which are 48,000 for Alex and John, who needs current age is 32 years, he wants to retire at 55 and expects to live 80 years. Now Alex and John have a surplus of 49,600 rupees each month. The first option that we suggested is 46,893 rupees of investment towards retirement would not leave much amount to be invested towards other goals. If their surplus is just 49,600 rupees, so this option cannot be accepted. If the second option is accepted, they would still have twenty one thousand rupees extra to be invested towards the remaining two goals. If we choose option 1 in both the remaining two goals, the addition works out to be twenty four thousand, but the surplus is just 21,000, but the difference is also minimal.

It has been just three thousand so either Alex and John can work on their household expenses to bring it down by three thousand rupees or they could straightaway choose option 2 in the remaining two goals as well. One more point to mention is, Currently Alex and John have an EMI OF 60,000 rupees. After 3.3 years when they buy their bigger house, it will come down to thirty thousand rupees and in that scenario their surplus would be 79,600 rupees and in that case they could invest into option 1 of all the three goals because the collective investment that is required is around 71,000 rupees. So today we have seen the hierarchy of investment needs and we have seen how to choose the right options taking in view your surplus available. The next thing you need to do is, go and implement your plan and do periodically, review  your plan, whether your investments are giving you returns as required. You could keep an eye on a quarterly basis, but don't be in a hurry to immediately change your investments. Take that decision only if your investments are off track for three-plus waters. One more important thing is to move your equity investments into debt as a class when your financial goals come within three years. This completes our financial planning process. Hope the series has empowered you to create your own financial plan.